Economics According to Google

For decades, many of the brightest graduates in economics sought their fortune in finance. In coming years, they will seek it in marketing, as the Internet gives all companies the information-rich environment once available only in financial markets.

Varian

That’s the prediction of Hal Varian, an economist at the University of California at Berkeley. Mr. Varian is known to legions of students for his microeconomics textbooks and to the public for his columns in The New York Times. He also is a leading thinker on the economics of information, co-author of Information Rules. As of July 2 he is an example of the trend described above: he is chief economist at Google Inc., where he will build a team of economists, statisticians, and analysts to assist the company in “marketing, in human resources, in strategy, in policy related stuff.” He has given up his column but remains on the faculty at Berkeley.

In an interview with The Wall Street Journal, Mr. Varian talked about the job, about how Google is like a traditional business, who should feel threatened by it, why marketing is the new finance and the contributions economists will make to helping firms understand and develop their products. –Greg Ip

WSJ: How did this job come about?

Varian: I knew [Google CEO] Eric Schmidt. … When I wrote Information Rules [with Carl Shapiro], he said “send me the manuscript.” He was very helpful, read it, commented on it, and did a jacket quote. I bumped into him in New York at the World Economic Forum and he said ‘I’ve joined this company Google, you should come down and see what we’re doing… come and consult for us.’

Back in 2001 when I stepped down as dean at Berkeley, I thought I would take a leave for a year and do something in the real world. But then the real world seemed a little scary so I went to Google instead. There were only 400 people at Google back in 2002 [there are now nearly 14,000] and I had a great time working with them on a number of projects, primarily involving quantitative analysis of one sort or another. For example, I’ve studied the Google ad auction quite a bit and that turned out to be very interesting from an economic point of view.

After a 1 1/2 year leave I returned to Berkeley to teach on a part time basis, but I’ve continued to consult with Google for a few days a week. As the company has grown, the demands on my time have grown, and I finally decided to devote my full attention to Google. Everything you hear about Google is true: it’s a very exciting place to work. So after studying the tribes of Silicon Valley for several years, I’ve finally gone native.

WSJ: What does the job entail?

Varian: During my time at Google we have built up a world-class group of quantitative analysts, and the economics team will complement these existing resources. Google has a great infrastructure for data analysis, and a management team that is very receptive to quantitative methods and willing to invest in this area. So what more could you ask for?

In addition to working on analytics, I’ve also worked on various business strategy and public policy issues, and will continue to do so as the occasion arises. This set of issues will only get more important to Google as time goes on, so I expect that this will also involve a fair amount of my time.

WSJ: Is Google different from the traditional model of the firm taught in economics?

Varian: I don’t think the model for search is so different from the model for the media industry. Look at newspapers or magazines. You have a bunch of people trying to put interesting content in front of eyeballs and [sell] ads relevant to that content. The big difference is in the publishing business, all this stuff is negotiated. It just won’t scale for the Internet. That’s where the auctions come in, to handle the pricing on a real time basis.

WSJ: Is Google an example of a “winner take all” market, where “network effects” make it more valuable as it gets more users?

Varian: I don’t think [search] is a winner take all market at all, because it’s so easy to switch. You type a different URL into your browser. For eBay, the buyers want to go where there are the most sellers are and the sellers want to go where the buyers are. [In search] the advertisers want to be where the most users are [but] the users don’t want to be where there are the most advertisers.

WSJ: Is Google a greater threat to content providers, or to content organizers — like phone directories?

Varian: Google’s mission is to organize the world’s information and make it universally accessible and useful. Other people in that business will have a competitor. What’s happening now is you had telephone directory doing one thing and card catalogues doing another and classified ads doing something else. But now, the online world, not just Google, all say we can do information search through a single interface. That’s definitely shaking up that market.

WSJ: In the past, promising new economics PhDs who didn’t want to work in government or academia probably aspired to work on Wall Street. In the future, will they aspire to work at companies like Google?

Varian: I think marketing is the new finance. In the 1960s and 1970s [we] got interesting data, and a lot of analytic fire power focused on that data; Bob Merton and Fischer Black, the whole team of people that developed modern finance. So we saw huge gains in understanding performance in the finance industry. I think marketing is in the same place: now we’re getting a lot of really good data, we have tools, we have methods, we have smart people working on it. So my view is the quants are going to move from Wall Street to Madison Avenue.

WSJ: Is that because the Web can now provide companies with the density of information once available only for things like stock prices and interest rates?

Varian: Absolutely. Adaptive forecasting, how I revise my forecast to take account of updated information, you use that a lot on Wall Street, where you have time series of stock prices. And some of those things carry over into things that Google is doing, that have this real-time flow of data. How do I detect unusual events, and react to them?

WSJ: For example, a hedge fund wants to know if a stock is moving because of news, or random volatility.

Varian: That’s a problem on Wall Street, and on the Web: is this [drop in traffic] a bug, or a holiday in southern Germany?

WSJ: Will economists earn the money in marketing that they do in finance?

Varian: There’s this old line about Wall Street, this magic moment in a transaction when the money leaves one person’s hands, and goes to another, if you are there to catch a little as it drops off, you can do very well. I’m not sure if marketing has that same characteristic. We see resumes from hedge fund people. You take a bright quant person, that’s a natural place they want to go. But you burn out or decide you don’t really like it or have a change in ideas. People are motivated by other things.

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